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Public Sector Rationing and Private Sector Selection Simona Grassi Ching-to Albert Ma Departamento de Economía Department of Economics Universidad Carlos III de Madrid Boston University Calle Madrid, 126 270 Bay State Road 28903 Getafe (Madrid) Boston, MA 02215 España USA sgrassi@eco.uc3m.es ma@bu.edu Incomplete, preliminary. Do not quote, cite, or circulate. March 2008 Acknowledgement: We thank seminar participants at Boston University and at the Health Economic Policy conference in Crans Montana, Switzerland. The first author thanks the Italian Fulbright Foundation for financial support. Abstract We consider the interaction between a public sector and a private sector. The public sector has a limited budget to provide a good to some consumers. A private firm may supply the same good to those consumers who do not receive the good at the public system. Consumers differ in two dimensions. They have different wealth levels, and the costs of supplying this good to them may also differ. The wealth heterogeneity dimension is self-explanatory. The cost heterogeneity dimension arises because consumer characteristics may determine how much it costs to supply the good. In the health market, patients’ illness severity affects how much medical resources a course of treatment requires. The public regulator observes consumers’ wealth information, but not the cost information. The private firm observes consumers’ cost information, but not the wealth information. The public regulator aims t